A Higher Dollar Will Suggest Reversal Risk in S&P 500

The upside surges in the greenback this month should send some warning signals to investors watching inversely correlated assets.

NEW YORK (BestCredit.net) -- The SPDRS&P 500 Trust ETF (SPY) is now trading in mostly uncharted territory above 180, tracking activity in the S&P, which is higher now by roughly 29% for the year (on pace for the largest biggest annual gain since 1998). But while the broad momentum is clearly aimed in the bullish direction, profit-taking in liquidity-thinned markets and the performances seen in inversely correlated markets suggest that we will likely see some downside corrections in the major stock benchmarks heading into next year. At this stage, downside risk clearly outweighs upside potential, so while I do not expect an outright reversal in SPY, caution is warranted and it clearly makes sense to start trimming back on positions at current levels.

SPY and Inversely Correlated Assets

So, the next real question is when this optimism will start to pullback and give market prices a needed bearish correction. Upside strength in the SPDR S&P 500 Trust ETF has been undeniable, as investors start to deal with holiday-thinned trading conditions. There will be added incentive to book profits and wait for better entry levels into 2014. In addition to this, we have some cautionary signals that are currently being exhibited by inversely correlated assets and potential reasons for stronger-than-expected GDP performances in the fourth quarter that could lead large sections of the market to anticipate additional QE tapering at the U.S. Federal Reserve.

Bullish performances in the U.S. dollar tend to be seen when markets are in risk-averse modes, so the upside surges in the greenback should send some warning signals to investors watching inversely correlated assets. Since the strength of the upside momentum in SPY is so clear, it will be important to watch price activity if we are able to trade back into 177.95. This is an area of "resistance turned support," so if investors are unable to hold prices above this region, we could start to see some deeper pullbacks as markets prepare for lower-volume trading conditions.